SECTION 7. EXAMPLES

The following examples illustrate the application of this revenue procedure:

.01 Example 1 (1) Facts. (i) On a date subsequent to December 6, 2010, Borrower B issued a mortgage loan to lender L . At origination, the stated principal of B’ s loan was $100 million, and nine interests in real property ( X 1 through X ) secured the loan. L contributed the loan 9 to R, a REMIC.

(ii) At the time when the loan was originated and the liens were created, the fair market values of these properties were as shown in the center column below:

(1) The lien release is not a modification for purposes of § 1.1001–3(c) because it occurred by operation of the terms of the debt instrument (including a lien release pursuant to the exercise of a unilateral option of the borrower within the meaning of § 1.1001–3(c)(3)); and

(2) The terms providing for the lien release are contained in a contract that was executed no later than December 6, 2010.

.03 A “qualified pay-down transaction” is a transaction in which a lien is released on an interest in real property and which includes a payment by the borrower resulting in a reduction in the adjusted issue price of the loan by a “qualified amount” as described in section 5.04 of this revenue procedure.

.04 A “qualified amount” is an amount that is equal to or greater than at least one of the following:

(1) the sum of —

(a) the net proceeds available to the borrower from an arms-length sale of the property to an unrelated person;

(b) the net proceeds from the receipt of a condemnation award with respect to the property; and

(c) in a case to which (a) or (b) above applies, the net proceeds from the receipt of an insurance or tort settlement with respect to the property;

(2) an amount that is determined under the loan agreement and that equals or exceeds the product of —

(a) the adjusted issue price of the obligation at the time of the lien release; multiplied by

(b) a fraction equal to the fair market value at origination of the released interest, divided by the aggregate fair market value at origination of all of the interests in real property that secured the loan immediately before the lien release;

(3) the fair market value (at the time of the transaction) of the interest in real property the lien on which is released, plus the amount of any tort or insurance settlement that is expected to be, or has been, received with respect to the property and that is not reflected directly or indirectly in the property’s fair market value at the time of the transaction; or

(4) an amount such that, immediately after the transaction, the ratio of the adjusted issue price of the loan to the fair market value of the interests in real property securing the loan is no greater than what that ratio was immediately before the transaction.

.05 The term “net proceeds” for purposes of section 5.04(1) of this revenue procedure means the amount realized for purposes of computing gain or loss under section 1001.

.06 If, as of the date of the lien release, the servicer reasonably believes that the transaction satisfies one of the criteria set forth in section 5.04(3) or 5.04(4) of this revenue procedure, then that criterion is

(iii) Under the loan documents, in the event that some of the real collateral suffers a casualty loss, B may demand a release of the lien(s) on the affected collateral but may do so only if B pays down the loan with the proceeds of a sale of that collateral and the proceeds of any insurance settlement with respect to the casualty loss.

(iv) On Date 1, R released the lien on X 1 in a transaction that did not cause the mortgage loan issued by B to cease to be a qualified mortgage.

(v) Subsequent to Date 1, on Date 2, properties X 2 and X a casualty loss. Immediately prior 3 sustained to the casualty, properties X X 2 and 3 had an aggregate fair market value of $19.5 million. On Date 2, after

the casualty, they had a fair market value of $14.5 million.

(vi) Consistent with B ’s rights under the loan documents, B demanded a release of the liens on properties X X B to sell them. At the time the 2 and 3 to enable liens on these two properties were released, the values of the various properties securing the loan were as shown in the right-hand column in the table above. B disposed of properties X X 2 and 3 in an arms-length sale to an unrelated person. The net proceeds from the sale within the meaning of section 5.05 of this revenue procedure were $14 million, and B paid down the loan by that amount when B received those proceeds. Subsequently, B received $5 million as an insurance settlement with respect to the loss suffered

by the two properties, and B paid down the loan by an additional $5 million when those proceeds were received.

(2) Analysis. (i) Under § 1.860G–2(a)(8), R ’s release of the liens on properties X and X causes the loan to 2 3 cease to be a qualified mortgage unless the release takes place in a transaction that satisfies either paragraph (a)(8)(i) or paragraph (a)(8)(ii) of § 1.860G–2. The release of the liens on X and X does not 2 3 satisfy § 1.860G–2(a)(8)(ii) because the release is not pursuant to a defeasance. The lien release, however, satisfies § 1.860G–2(a)(8)(i) if the transaction in which it occurs meets the requirements of § 1.860G–2(a)(8)(i)(A) and § 1.860G–2(a)(8)(i)(B).

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real property for purposes of section 860G(a)(3)(A) and § 1.860G–2(a)(8)(i)(B).

.02 Example 2 (1) Facts. (i) Assume the same facts as in (i) and (iv) of Example 1. Assume further that the executed loan documents give B a unilateral right to obtain a release of any one or more of the properties that secure the loan, but only if B pays down 110 percent of the “allocated loan amount” for the property or properties the liens on which are being released. The loan documents define “allocated loan amount” as the proportionate loan balance of the properties on which liens are released, based on the relative appraised values of the properties at origination of the loan.

(ii) At the time when the loan was originated and the liens were created, the fair market values of the nine properties securing the loan were as shown in the center column below. The appraised values at that time were the same.

(ii) The transaction in which the lien was released resulted from the exercise of an option that is unilateral within the meaning of § 1.1001–3(c)(3). Thus, the transaction is not a significant modification as defined in § 1.860G–2(b)(2) and therefore is described in § 1.860G–2(a)(8)(i)(A). In addition, however, to satisfy § 1.860G–2(a)(8)(i)(B), the loan must continue to be principally secured by an interest in real property as determined by § 1.860G–2(b)(7).

(iii) The release of the lien on X and X does 2 3 not satisfy the 80-percent test in § 1.860G–2(b)(7)(ii) or the alternative test in § 1.860G–2(b)(7)(iii). The loan, however, continues to be treated as principally secured by an interest in real property if this release and the associated paydown of the loan are within the scope of section 5 of this revenue procedure.

(iv) The release of the liens on properties X 2 and X 3 is not part of a grandfathered transaction described in section 5.02 of this revenue procedure because B issued the loan after December 6, 2010.

(v) The release of the liens on properties X and 2 X, however, is within the scope of section 5.03 of this 3 revenue procedure if it is part of a “qualified paydown transaction.” First, the transaction involved a release of a lien on an interest in real property and included a payment by the borrower that resulted in a reduction in the adjusted issue price of the loan. Second, the transaction meets the requirements of both section 5.03(4) and section 5.03(1) of this revenue procedure. Third, the payment by the borrower to reduce the adjusted issue price of the loan is a “qualified amount” as described in section 5.04(1) of this revenue procedure. The qualified amount is $19 million, which is the amount realized for purposes of computing gain or loss under section 1001 of the Code. Thus, the transaction satisfies the requirements of section 5.03 of this revenue procedure. Therefore, under Section 6 of this revenue procedure, the Service will not challenge the mortgage loan’s status as a qualified mortgage on the grounds that, following the release of the liens, it fails to be principally secured by an interest in

(iii) At a time when the fair market values of X 2 through X B exercised its right 9 had declined by 35%, to obtain a release of the liens on X X . Immedi_2_ and 3 ately before R released the liens, the loan’s adjusted

issue price (within the meaning of § 1.1275–1(b)) for federal income tax purposes was $79 million (as a result of amortization and prepayments on the loan). The unpaid loan balance for purposes of computing

the allocated loan amount under the loan agreement was $80 million. To obtain the lien release, B paid $29,333,333 to reduce the unpaid principal on the loan. This amount was determined as—

1.10 × $80,000,000 × ([$5,000,000 + $25,000,000] / [$5,000,000 + $25,000,000 + $60,000,000])

(iv) Immediately before and after the lien release and paydown, the values of properties X through 2 X were as shown in the right-hand column in the 9 table above. Thus, the aggregate fair market value ($39 million) of the interests in real property that secured the loan immediately after the release of the lien was less than 80 percent of the loan’s adjusted issue price ($49,666,667). ($49,666,667 = $79,000,000 $29,333,333). ([39,000,000 / 49,666,667] = 78.5 percent).

(2) Analysis. (i) Under § 1.860G–2(a)(8), R ’s release of the liens on properties X X 2 and 3 causes the loan to cease to be a qualified mortgage unless the release takes place in a transaction that satisfies either paragraph (a)(8)(i) or paragraph (a)(8)(ii) of § 1.860G–2. The release of the liens on X and X does not satisfy 2 3 § 1.860G–2(a)(8)(ii) because it is not pursuant to a defeasance. The release of the liens on X X 2 and 3, however, satisfies § 1.860G–2(a)(8)(i) if the transaction in which the liens are released meets the requirements of § 1.860G–2(a)(8)(i)(A) and § 1.860G-(a)(8)(i)(B).

(ii) The transaction in which the liens were released resulted from the exercise of an option that is unilateral within the meaning of § 1.1001–3(c)(3). Thus, the transaction is not a significant modification as defined in § 1.860G–2(b)(2) and therefore is described in § 1.860G–2(a)(8)(i)(A). In addition, however, to satisfy § 1.860G–2(a)(8)(i)(B), the loan must

continue to be principally secured by an interest in real property as determined by § 1.860G–2(b)(7).

(iii) The release of the liens on X and X does 2 3 not satisfy the 80-percent test in § 1.860G–2(b)(7)(ii) or the alternative test in § 1.860G–2(b)(7)(iii). The loan, however, continues to be treated as principally secured by an interest in real property if the release and the associated paydown of the loan are within the scope of section 5 of this revenue procedure.

(iv) The release of the liens on properties X 2 and X 3 is not part of a grandfathered transaction described in section 5.02 of this revenue procedure because B issued the loan on a date after December 6, 2010.

(v) The release of the liens on properties X and 2 X, however, satisfies section 5.03 of this revenue 3 procedure if it is part of a “qualified paydown transaction.” First, the transaction involves a release of a lien on an interest in real property and contains a payment by the borrower that results in a reduction in the adjusted issue price of the loan. Second, because the transaction is pursuant to the terms of the loan document and is not a modification for purposes of § 1.1001–3, the condition in section 5.03(1) of this revenue procedure is satisfied. Third, the payment by the borrower to reduce the adjusted issue price of the loan is a “qualified amount” because it is not less than the amount described in section 5.04(2) of this revenue procedure. The $29,333,333 amount by which the loan was paid down (the contractually determined

allocated loan amount) is greater than the minimum amount of $26,333,333, which is required by section 5.04(2). ($26,333,333 = [79,000,000 × (30,000,000 / 90,000,000)]). (The value of X at origination is 1 not included in the denominator because X did not 1 secure the loan immediately before the lien release.) Thus, the transaction is a qualified paydown transaction within the meaning of section 5.03 of this revenue procedure, and, therefore, under section 6 of this revenue procedure, the Service will not challenge the mortgage loan’s status as a qualified mortgage on the grounds that, following the release of the liens, it fails to continue to be principally secured by an interest in real property for purposes of section 860G(a)(3)(A) and § 1.860G–2(a)(8)(i)(B).

.03 Example 3 (1) Facts . (i) Assume that the facts are the same as (i) of Example 2, except that at origination there was also a tenth property ( X ) securing the loan. Property X 10 10 was an “outparcel,” which had not been appraised at the time of origination of the loan and to which L had not assigned any value in underwriting the loan. The loan documents at origination granted B an unconditional right to demand a release of the lien on X 10 at any time, without making any special payment on the loan. Although the value of property X was small 10 compared to properties X X, it was positive 1 through 9 at all times relevant to this example. Moreover, at the

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time of the lien release described below, the servicer of the loan knew or had reason to know that the fair market value of X 10 had been positive at origination.

(ii) At the time when the loan was originated and the liens were created, the fair market values of the

ten properties securing the loan were as shown in the center column below. Except for property X >, the 10 appraised values at that time were the same. Immediately before and after the lien release, the fair market values of properties X - through X - were as shown 2 10

in the right-hand column below. (Except for property X >, the information in this table is the same as that 10 in Facts (ii) of Example 2.)

these concerns and simplify tax administration, this revenue procedure provides that, if the requirements of this revenue procedure are satisfied, the IRS will treat an election under § 301.7701–3(c) to classify a foreign eligible entity that is a qualified entity (as defined in section 3.02 of this revenue procedure) as a partnership or disregarded entity as an election to be treated as a partnership or disregarded entity (as appropriate) rather than as an association taxable as a corporation.